04 May 2010: Small Company IPOs The Pitfalls

By David Perry, Associate, Investor Relations and Financial Communications

Small Company IPOs The Pitfalls

A large proportion of small company IPOs end the first year after listing with lower share prices than on listing day.  This has negative consequences in both the short and medium term. Below are some views on why so many companies dont pass the initial test.

1. It is much easier for small companies to float when the market is rising:  As the share market rises, company owners find it easier to float and investor demand and risk tolerance rises. But this can all change quickly and investors can turn on a company, particularly if their expectations of performance are dashed.

2. The IPO sprint and prize: There is a tendency for many companies to see an IPO as the pot of gold at the end of a short sprint. However, the IPO is really the warm-up to the start of a professional long-distance race.

3.  One of manyand professional investors see every flaw:  Institutional investors have seen hundreds of companies and heard hundreds of stories. So weaknesses in a particular companys story will be readily apparent to them.  Also, very few institutional investors and analysts are going to bother with you unless you are of a certain size and liquidity.

4.  Punishments are more severe in the market: Companies tend to list when the business is doing well. Management budgets and projections are often on the over-optimistic side and dont allow for contingencies. Conditions change and failure to meet projections are met with penalties. Small companies learn a harsh lesson: the penalties for under-performance are magnified in a listed environment. And investors have long memories. 

5.  If you cant hack the pace at the beginning of the race: In the first year of listing, credibility is on the line. The investment markets see the first year of listing as a real barometer of a companys strategy and managements credentials. So the first year is more about the future than it is about the companys performance to date. If a company cant hack the pace at the beginning of the race, its reputationand share pricewill be damaged.

6.  The IPO process distracts from the business.  Most private companies significantly underestimate the amount of effort required by management to get to the IPO.  This means less attention to the business and the risk of a market penalty for underperforming, until momentum is regained. 

7.  Underestimating a public companys demanding investor obligations:  Private companies significantly underestimate what is takes to be a successful public company in terms of  (a) the culture of disclosure revealing the bad and good, in a continuous disclosure regime, and: (b) professional investor relations and communications.  The focus is very much on the listing process with little if any planning of post-listing IR. Corporate Outcomes Group can put together an IR program to assist newly listed companies or companies that are about to list and provide IR support and training until such time as the relevant skills and resources are available in house.

8.  Speaking the language of the market: Companies need to understand the language of the market to communicate with it.  e.g. EPS, ROE, free-cash flow, DCF, capex, earnings targets, dividend and gearing policies, etc, and how these all interrelate. New companies who cant talk the talk risk not getting their message across and/or sending the wrong messages. 

9. Keeping the balancein favor of investors: The reasons for an IPO have to do with (a) growth and better access to the capital marketswhich is the focus of investorsand (b) providing liquidity and an exit point for some existing shareholders. Investors expect the balance should be much more in favour of growth but, for many owners, it is the release of liquidity often in the form of a new house or car resulting in less attention being paid to the business.

10. We know better: the biggest pitfall of all. The market is much, much bigger than any individual company and there is an important investment law that companies misunderstand at their peril the market is always right.  There is no use criticizing or preaching to the market.

For further information, contact David Perry or Adrian Cran, our Chief Corporate Advisor.